FRM Part II · FRM Exam Part II · Factors
An investor holds a long-only portfolio of low-volatility stocks and finds it earned returns similar to the market with much lower total volatility. Which characteristic best explains why a low-volatility strategy often shows a positive alpha relative to the CAPM?
Low-beta, low-volatility stocks have historically earned more than the CAPM predicts for their beta, so they plot above the security market line and show positive alpha. This low-risk anomaly is often linked to leverage constraints and investor preference for high-risk, lottery-like stocks.
- ALow-beta stocks have historically earned higher returns than the CAPM security market line predictsCorrect
- BLow-volatility stocks have higher market betas than the index
- CLow-volatility stocks are always the smallest firms in the market
- DLow-volatility portfolios earn a premium for bearing illiquidity only
Explanation
The low-risk anomaly is that low-beta or low-volatility stocks have plotted above the security market line, producing positive CAPM alpha, partly attributed to leverage constraints and lottery-like preferences for high-beta stocks. The other options misstate beta or size.
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